Demand > Supply
The economy has experienced two straight months of disappointing job growth while residential construction activity decelerated to begin the year. At this point, it is difficult to draw any conclusions on whether the recent weakness is just a blip on the radar or a sign of protracted weakness. Poor weather around the country has undoubtedly had some impact on slowing down housing demand. However, rising mortgage rates due to the Fed taper and major regulatory changes in the New Year are also playing a role.There are many ways we evaluate conditions in the housing market. Metrics involving affordability, supply/demand, and consumer sentiment are amongst the most common. Earlier, we talked about slower job growth and building activity which happen to be the components to one of our closely-watched metrics, the E/P ratio. The E/P ratio is annual job growth in a given period divided by the number of building permits issued during that same time. This ratio uses employment growth as a gauge to show where supply is in relation to demand based on job creation. Some of our findings are listed below:
- Demand is still outpacing supply. Despite weaker job growth, there remains a shortage in housing supply to satisfy current demand. The E/P ratio reached a reading of 2.5 in January which is down noticeably from a reading of 2.9 just two months before that in November when the economy added 274,000 payrolls. Job growth is expected to pick up which will only create more demand. Forecasts from Zonda, which is a new mobile application serving the residential homebuilding industry, shows that unemployment will finish 2014 at 6.4% which will be its fourth consecutive year of improvement.
- Weaker job growth has been matched with slower building activity. Even though job growth has been weak, the E/P ratio hasn’t been dragged down too much because of slower building activity. As long as the two remain in relative balance, we will avoid overbuilding that could result in excess supply.
- All local markets have their own dynamics. Although the U.S. as a whole might be facing a shortage in housing supply, it does not mean that every locale is experiencing the same thing. In Zonda, we analyze the E/P ratio from the national level all the way down to the county level. Areas like San Mateo County in California touts an E/P ratio of 7.4 because of a strong job market and limited development activity while Wayne County’s E/P ratio in Michigan is only 0.3 because of poor labor market conditions and an embattled housing market.
- Trends in household employment and size have shifted. Household size had been steadily declining over the past half a century but that trend stalled when the Great Recession hit. The recession caused more people to move back in with their families and resulted in more income-producing members under one household. This may temporarily change what we consider equilibrium when comparing job growth with housing supply.
It will take a couple more months before we can really determine how much weather had to do with the slow start to the year. By that time, we will see if a sluggish winter resulted in more pent up demand or if there is really some underlying weakness in the overall economy. Watch the fluctuations and trends in the E/P ratio going forward to see if supply and demand are moving in tandem or diverging. This will give you an idea if more building is necessary and where home prices may be headed.